A Closer Look At Silver Wheaton’s Penasquito Mine

Silver Wheaton (NYSE:SLW) is a silver streaming company that signs long-term purchase agreements with mining companies producing silver or gold as by-product. It provides funds for capital expenditure upfront when a project is being developed and obtains the right to buy precious metals produced at low, fixed prices. It does not pay for any ongoing capital or exploration costs at the mines. Thus, the company’s costs are one-time and fixed, which greatly reduces its business risk.

The silver or gold obtained at a fixed price is sold at market rates, which exposes it to the daily volatility of these metals’ prices. Its gains increase when market prices of silver and gold rise. The prices of precious metals have been on a continuous decline this year, but we expect them to stabilize going forward. Apart from use in jewelry, silver is an industrial metal as well. This ensures a relatively steady demand for silver as compared to gold.

In this article, we will focus specifically on the company’s silver streaming business from the Penasquito mine. It is Mexico’s largest open pit mine and is owned and operated by Goldcorp. Below, we talk about the reserve base at this mine, expected output, upfront payments made by Silver Wheaton, and the per ounce cash cost paid.

See our full analysis for Silver Wheaton

The Penasquito Mine

The Penasquito mine is host to world-class gold-silver-lead-zinc deposits. It is located in the northeastern portion of the State of Zacatecas and consists of two open pits – Penasco and Chile Colorado. In July 2007, Silver Wheaton entered into an agreement with Golcorp to purchase 25% of the silver produced at Penasquito over the life of the mine. ^[1]

As of March 31, 2013, Silver Wheaton has received approximately 15.4 million ounces of silver from the Penasquito mine under the agreement, and has generated cumulative operating cash flows of approximately $388 million.  On December 31, 2012, its 25% share of Penasquito’s proven and probable silver reserves stood at 227.9 million ounces, measured and indicated silver resources at 63.1 million ounces and inferred silver resources at 9.9 million ounces. ^[2]

Penasquito is expected to produce an average of 28 million ounces of silver annually over an initial 22-year mine life. With Silver Wheaton entitled to 25% of total produce, it is expected to receive approximately 7 million ounces of silver annually. In 2012, it received 6.57 million ounces of silver from Penasquito and sold 5.98 million ounces. At average realized prices of $31.03 per ounce of silver, this translates to revenues of nearly $185.5 million. Total revenues in 2012 for the company stood at $849.6 million, and the Penasquito mine alone accounted for nearly 22% of the company’s revenues. ^[3]

As per the agreement between Silver Wheaton and Goldcorp, the former made an upfront cash payment of $485 million in 2007. Also, Silver Wheaton will buy silver for the lesser of $3.9 per ounce (subject to an annual inflationary adjustment three years after commencement of commercial production) and the prevailing market price when the delivery is made. Silver Wheaton is not required to fund any further capital or exploration expenditures at Penasquito, nor is it required to fund any expansion scenarios.

Assuming a 22-year mine life (as mentioned earlier) the upfront cost per year can be assumed to be $22 million (485/22 ~ 22). If Silver Wheaton receives 7 million ounces each year as expected, the cost per ounce would be nearly $3.14. Added to the fixed cost of $3.9 per ounce, the total cost of purchase would stand at around $7 per ounce. Given that silver is still trading at around $22 per ounce despite the steep decline in prices this year, we think that it is a good deal by any standard. ^[4]

Benefits To Silver Wheaton

In our opinion, the deal fixes the price of silver at a relatively lower figure considering the huge jump in the cost of production over the last few years. Going forward, we think that production costs will rise further owing to higher costs associated with labor, energy, and regulatory compliance. Silver Wheaton, however, will be insulated from these owing to its fixed-price contracts. Also, with industrial demand expected to pick up eventually, the market price of silver is likely to rise despite the slump being witnessed now. This will allow streaming companies like Silver Wheaton to earn good returns. Hence, we think that Silver Wheaton has got itself a good deal at Penasquito.

We have a price estimate for Silver Wheaton of $38.

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1. The Penasquito Mine, Silver Wheaton Website [↩]
2. Silver Wheaton Q1 2013 6-K, SEC [↩]
3. Silver Wheaton 2012 40-F, SEC [↩]
4. Silver Price Charts, Kitco [↩]